VW to Build New Plant in Central Russia

According to a report in Russian business daily Kommersant, it appears that Volkswagen (VW) has finally found a suitable location to establish its first assembly plant in Russia. After seriously considering a site near Moscow, VW has then looked at other options in the St Petersburg, Vladimir and Yaroslavl regions but has selected the Kaluga region to build its plant. Although VW has not yet confirmed the news, since plans to set up capacity in Russia were approved by the VW supervisory board in April 2006, the carmaker said it would have finalised the project by May. A formal announcement is expected next week.

VW has been studying and negotiating its entry into Russia for the past three years. At the end of 2005, the carmaker announced that it was ready to invest 400 million euro (US$514 million) in the construction of a new plant capable of producing 250,000 cars per annum. VW is likely to start with the assembly of the Skoda Octavia and VW Gol from semi knocked-down (SKD) kits in 2007. At this point, it seemed that VW had selected a construction site in the city of Stupino, close to Moscow. Last week VW appeared to have completely abandoned its initial plans to make cars in Stupino, after the Moscow region was declined the rights to create a special economic zone, a status  that would have allowed it to grant generous tax relief to investors.

Against this backdrop, VW is now heading toward the Kaluga region and is expected to build its plant in an industrial zone near the local airport. The Kaluga region is part of the Central Federal District and is in a very convenient and favourable location owing to the well-developed transportation network. Another reason that may have attracted VW there is very interesting investment incentives offered by the local authorities. It is believed that the region will participate in developing infrastructures around the facility. Moreover, VW will be not pay profit taxes to the regional budget and will be exempted from property tax for four years. VW has already reached an agreement with the Russian government to receive privileged import conditions on components in exchange for sourcing up to 30% of the car's value locally and starting with production of at least 25,000 units per annum.

Outlook and Implications

With an investment in excess of 400 million euro required to set up its first plant in Russia, VW has expansive views on the Russian market. Ford has injected US$150 million in its plant near St Petersburg where it currently builds about 60,000 units per annum, while Renault has invested US$250 million in upgrading the Avtoframos plant in Moscow to start production of the Logan. VW is reportedly planning to construct component park next to the plant, which will have an initial capacity of 115,000 units per annum. 

The future arrival of VW means that over the past six months or so, three major automaker have decided to invest in Russia and are likely to join soon by General Motors (GM) and Nissan while a number of other car companies have formed vital industrial alliances with local manufacturers. Russia's Severstal-Avto has signed licensing agreements with Fiat, SsangYong and Isuzu. AvtoVAZ and GM are producing the Chevrolet Niva in Russia, BMW, GM have a licensing agreement with Kaliningrad-based Avtotor while Hyundai collaborates with TagAZ and Izh-Avto. Russia's plans to attract foreign direct investment by proposing the reduction of import duties on assembly components for carmakers prepared to invest in capacity and source a significant proportion of parts locally, coupled with booming demand for modern cars, has led to the sudden arrival of several companies in the country, particularly around St Petersburg. It will directly bring some momentum to the local automotive sector which has been stifled by years of protectionism and underinvestment. Since foreign carmakers can be entitled to lower import duties on a vast majority of components, it is no surprise that they also try to take advantage of lower logistical costs by taking advantage of the port of St Petersburg, which keeps them connected to the rest of the world. However, this was not an issue for VW, which is creating enough space to accommodate a number of key suppliers next to the plant. 

Foreign carmakers are hastening their entry to Russia, not only to take advantage of a rapidly growing domestic market but also because Russia will no longer offer advantageous import conditions to foreign carmakers after it joins the World Trade Organization (WTO) as the tax privilege offered on imported components is against the WTO rules. However, although Russia has made significant progress in its attempt to accede to the WTO by the end of 2006, a formal accession is not expected in the near future as Russia has made it clear that it is ready to delay its accession to WTO rather than enter on unfavourable terms.

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